ABS in line for surprise pardon as covered, senior markets falter
Euroweek
17 Jun 2011
Bill Thornhill
Securitisation - widely vilified for exacerbating the global credit crisis - may be about to receive an unexpected boost that could see it return as a crucial source of liquidity for the European bank finance market.
In a keynote address at the Global ABS Conference in Brussels this week, Francesco Papadia, director general of market operations at the European Central Bank, criticised the mismatch between central bank repo criteria and eligible liquid assets for banks.
It was a move that many market experts interpreted as an implicit backing for European securitisations to become eligible level two liquid assets under the European Union's implementation of Basel III, CRD IV.
This would greatly lift European bank demand for securitised assets, reduce a potentially dangerous overreliance on covered bonds and provide much needed extra liquidity at a time when the senior bond market is struggling to meet the capital needs of the banks.
As a major investor and liquidity provider, the ECB is in the strongest position to drive the agenda and bring in a more informed and balanced approach to regulation.
Good liquidity regulation would avoid unwarranted cliff effects between assets inside and outside regulations, said Papadia. Matching central bank repo criteria and bank liquid assets would avoid market-distorting arbitrage effects, he said.
Papadia is obliquely referring to the fact that covered bonds, being eligible assets under Basel III's liquidity coverage ratio, sit comfortably inside the regulatory regime. By contrast, ABS are not eligible for LCR inclusion and is therefore outside the regime.
The market distorting effects reflect his view that triple-A rated ABS qualify for emergency central bank repo funding - but covered bonds that are downgraded to sub-investment grade do not.
"I don't see why covered bonds are included as liquid assets in the LCR when RMBS are not," said Arjan Verbeek, head of flow products at BNP Paribas, in a panel discussion on covered bonds at the conference.
In this respect, it is noteworthy that the Australian Prudential Regulation Authority views RMBS as eligible liquid assets simply because they can be posted for repo funding with the Reserve Bank of Australia.
Both markets need to be strong
Given much higher ratings volatility for the covered bond market compared to the prime RMBS market, it is far from certain that a covered bond issuer would be able to access emergency central bank funding when it most needs it.
As much as a quarter of the covered bond ratings would be downgraded by Moody's if the issuer was downgraded. In contrast, prime European RMBS have held their initial rating from triple-A to single-A throughout the entire crisis - irrespective of the issuer.
Martin Rast, a vice president and senior analyst at Moody's, speaking on a covered bond panel at the conference, conceded that there was a limit to the level of over-collateralisation that a covered bond issuer would be prepared to put into its programme to avoid a rating downgrade and said the question of whether the covered bond sector can function as a non-triple-A market "remains to be seen".
Regulators are also worried. "There is a limit to how far over-collateralisation can go, without significantly raising the risk to deposits and other senior obligations of the bank," said Thomas Huertas, alternate chairman of the European Banking Authority, at the conference.
PCS a gateway
The Prime Collateralised Securities initiative, which aims to hard code standardised transparency into the ABS market, is likely to be the main route to changing the current regulatory bias, opening the way for the inclusion of certain securitisations as eligible assets for liquidity purposes.
On the presumption that progress will be made on this front "there is a good chance ABS will make it into level two," of the LCR, said Mauricio Noé, head of covered bond origination at Deutsche Bank.
The one thing that could really catalyse that process is if the European Commission gave a helping hand. Speaking at the conference, Elemer Tertak, principal advisor on financial institutions at the European Commission, said the EC had not ruled out the inclusion of ABS into the LCR and said it is currently in an observation period.
The ECB's Papadia said he also believes the ABS market needs a "strong role model", demonstrating the highest standards of simplicity and transparency with defined conditions for LTVs and data provision. He said it should be well documented and credible, and called on the industry to "forcefully pursue this initiative".
But the PCS initiative has had a mixed reception, mainly because it would be difficult to apply standardisation across all jurisdictions as each has its own idiosyncratic features - both in terms of the assets and structures.
A case in point is the Dutch RMBS market. Though its RMBS are among the lowest risk, best performing deals in Europe, the LTV ratios are much higher than average due to the impact of local tax relief on mortgage interest payments. Imposing an arbitrary LTV threshold could mean such RMBS fail the PCS kite mark - despite being top quality.
Objections to the scheme have also arisen because, initially at least, UK master trust structures would not have qualified.
There are also concerns that the creation of a PCS label would mean that a vetting body would need to be set up which, in effect, rates deals. This would lead to delays in deal execution time and higher transaction costs.
Vicky Ford, an MEP for the UK's Conservative Party and spokesman on Economic and Monetary Affairs, warned at the conference that the PCS would not work, as like covered bonds, the ABS market is far from homogenous.
Despite her downbeat assessment, some of the biggest opponents of the scheme have slowly come around to the idea that it is better to be involved and help shape the initiative than have no control whatsoever.
When the scheme was originally cobbled together well over a year ago, the European Commission asked UniCredit, the Association for Financial Markets and the European Securitisation Forum to come up with the ideas for the label.
UK issuers were invited to the table several months later but viewed it as unworkable and costly and by mid-summer 2010 the initiative had ground to a halt.
Investor response was, and remains, indifferent. Issuers to some extent continue to feel that it should only go ahead if the regulatory benefit is assured.
The regulators are not committing to anything, but they have warned that if the initiative does not go ahead there is absolutely no chance of preferential regulatory treatment.
Their no-carrot-all-stick approach may have worked. In the last year teams of consultants have worked to get something that could become workable - both in terms of structures being employed and jurisdictions.
Former opponents of the initiative now say that it is on a proactive track and they believe there is a chance something could get implemented. They are aware that the costs and efforts may never pay off, but that it is a price worth paying for the chance to get preferential treatment.
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